4. SUPPORT AND RESISTANCE TRENDLINES AND CHANNELS

There are two terms that define the peaks and troughs on the chart.A previous trough usually forms a support level. Support is a level below the market where buying pressure exceeds selling pressure and a decline is halted. Resistance is marked by a previous market peak. Resistance is a level above the market where selling pressure exceeds buying pressure and a rally is halted (See Figure 4-1).


Support and resistance levels reverse roles once they are decisively broken. That is to say, a broken support level under the market becomes a resistance level above the market. A broken resistance level over the market functions as support below the market.The more recently the support or resistance level has been formed,the more power it exerts on subsequent market action.This is because many of the trades that helped form those support and resistance levels have not been liquidated and are more likely to influence future trading decisions (See Figure 4-2).


The trendline is perhaps the simplest and most valuable tool available to the chartist.An up trendline is a straight line drawn up and to the right, connecting successive rising market bottoms. The line is drawn in such a way that all of the price action

is above the trendline.A down trendline is drawn down and to the right, connecting the successive declining market highs. The line is drawn in such a way that all of the price action is below the trendline. An up trendline, for example, is drawn when at least two rising reaction lows (or troughs) are visible. However, while it takes two points to draw a trendline, a third point is necessary to identify the line as a valid trend line. If prices in an uptrend dip back down to the trendline a third time and bounce off it, a valid up trendline is confirmed (See Figure 4-3).


Trendlines have two major uses.They allow identification of support and resistance levels that can be used, while a market is trending, to initiate new positions. As a rule, the longer a trendline has been in effect and the more times it has been tested, the more significant it becomes.The violation of a trendline is often the best warning of a change in trend.

Channel lines are straight lines that are drawn parallel to basic trendlines. A rising channel line would be drawn above the price action and parallel to the basic trendline (which is below the price action). A declining channel line would be drawn below the price action and parallel to the down trendline (which is above the price action).Markets often trend within these channels.When this is the case,the chartist can use that knowledge to great advantage by knowing in advance where support and resistance are likely to function (See Figure 4-4).